Kayak’s Valuation Significantly Impacted By Google-ITA Deal

Kayak, the leading travel search company, starting trading Friday after the company priced its initial public offer (IPO) at $26 a share. Unlike online travel agencies like Expedia (NASDAQ:EXPE) or Priceline (NASDAQ:PCLN), Kayak does not provide online bookings directly but gives consumers a one-stop research solution to best fares, along with other value-added services like flight status updates and pricing alerts.

Along with the rest of the online travel industry, Kayak is also slated to benefit from favorable trends in the industry such as – improving economic situation, growing travel demand from emerging economies, rising internet penetration, among others. However, Google’s (NASDAQ:GOOG) acquisition of ITA software, a provider of online travel faring information, poses a major threat to all online travel agencies’ and particularly to Kayak’s current valuation.

In July 2010, Google (NASDAQ:GOOG) announced an agreement to acquire ITA Software. ITA licenses its airfare search and pricing software to Kayak under an agreement which expires in December 2013. The faring software has historically accounted for as high as 60% of Kayak’s overall airfare query results and airline travel queries account for 85% of total searches performed on Kayak’s websites and mobile applications.

With the regulatory approval of the acquisition in April 2011, Google has the capacity to create its own flight search tool which enables people to find comparable flight information on the Internet without using Kayak’s services.

Alternatively, Google may not renew ITA’s current agreement with Kayak, or do so at unfavorable terms. If Kayak is unable to replace ITA with a comparable technology, it could significantly effect the company’s revenues and operating margins by impacting the comprehensiveness of query results.

Is Kayak Hedging Its Dependence On ITA Software ?

While ITA’s current contribution to total airfare query results (39%) continues to be significant, the percentage has significantly come down from 60% few months back (as per Kayak’s November 2011 S-1 filing). Kayak recently announced a multi-year agreement with its long-term technology partner Amadeus where it expanded the use of the latter’s airline fare and availability technology for more comprehensive flight search results.

Though, the company does not disclose the contribution of Amadeus in its total query results, we feel that the extension in the agreement strengthens the partnership between the two companies and could be indicative of Kayak’s strategy to reduce its reliance on ITA software.

However, Kayak continues to claim that the alternate faring engines solutions do not currently provide the level of comprehensiveness and accuracy that ITA’s software offer. Thus, by negatively impacting airline query results from Kayak, the Google-ITA partnership might impact the company’s future valuation.

If the total airline ticket queries increase to only 2 billion as opposed to 2.8 billion currently estimated by us, then we would see an over 15% decline in our price estimate.

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